China Proposes Unprecedented Nationalization Of Insolvent Companies: Banks Will Equitize Non-Performing Loans

In what may be the biggest news of the day, and certainly with far greater implications than whatever Mario Draghi will announce when we will again witness the ECB doing not “whatever it takes” but “whatever it can do”, moments ago Reuters reported that China is preparing for an unprecedented overhaul in how it treats it trillions in non-performing loans.

Recall that as we first wrote last summer, and as subsequently Kyle Bass made it the centerpiece of his “short Yuan” investment thesis, the “wrote last summer” in the heart of China’s impaired financial system is the trillions – officially at $614 billion but realistically anywhere between 8% and 20% of China’s total $35 trillion in bank assets – in non-performing loans. It is the unknown treatment of these NPLs that has been the greatest threat to China’s just as vast deposit base amounting to well over $20 trillion, which has been the fundamental catalyst behind China’s record capital flight as depositors have been eager to move their savings as far from China’s domestic banks as possible.

As a result, conventional thinking such as that proposed by Bass, Ray Dalio, KKR and many others, speculated that China will have to devalue its currency in order to inflate away what is fundamentally an excess debt problem as the alternative is unleashing a massive debt default tsunami and “admitting” to the world just how insolvent China’s state-owned banks truly are, not to mention leading to the layoffs of tens of millions of workers by these zombie companies.  

However, China now appears to be taking a surprisingly different track, and according to a Reuters reported  China’s central bank is preparing regulations that would allow commercial banks to swap non-performing loans of companies for stakes in those firms. Reuters sources said the release of a new document explaining the regulatory change was imminent.